Necessary but not sufficient redux – Inability of ERP vendors to think logically

Redux is an adjective meaning "brought back, restored"

The headline SAP's CEO Resigns: Delays in Launching Online Business Software Cited as One Reason for Downfall
brings the prophetic nature of Eliyahu Goldratt's novel "Necessary but not sufficient" into immediate relevance. Goldratt had written the novel to alert the ERP vendors, which were held as stock market darlings in the late nineties, against the bumpy road ahead. These companies were attracting a PE multiple of 100 mostly due to their growth track record rather than their profitability.

Goldratt had logically pointed out that ERP vendors had wrongly surmised that in order to make the customers happy they needed to keep on adding newer and newer features. This race for adding features to make the ERP application as comprehensive as possible was resulting a very complex software. In order to compete with each other, these vendors were releasing incomplete and bug-ridden application to the clients. This in turn was making it difficult to implement for the implementation partners and difficult to troubleshoot whenever bugs were reported by the clients and implementation partners, which was happening with more and more regularity. These facts had started appearing in reality and they pointed to the future where ERP vendors would stop growing at a scorching pace. Another factor that would be contributing to brakes on growth was that almost all of Fortune 1000 organizations had implemented one or the other ERP. These organizations had implemented ERP in their drive to replace the legacy software before the purported Y2K disaster. Moreover, the ERP application was in a position to provide visible bottom-line improvements by shrinking the time that information was travelling through the geographically diverse locations where such large organizations had presence. The sub-Fortune 1000 organizations, popularly known as SMEs (Small and Medium Enterprises), did not have legacy applications that needed to be replaced before Y2K and hence wanted to have a bottom-line orientation for their decisions.

ERP vendors did not have any story, other than jazzy features and catchy phrases like system optimization, or greater operations visibility, then. They still do not have a credible story of why any organization should implement ERP and go through a very painful change. The key benefits that ERP can bring to organizations - large, medium or small, but which ERP vendors and their implementation partners do not focus on are:

1. Reduction in lead-time
   
2. Increasing the reliability in delivery measured as On-time-in-full delivery %
   
3. Reduction in inventory
   
4. Increase in sales.
   
5. Reduction in material costs,
   
6. Reduction in the days of outstanding receivables
   

It seems the ERP vendors did not draw any lessons from that warning. They are still too dazzled by technical wizardry their techies can throw-up. The debate around on-premise and hosted (SAP V/s Netsuite) points towards this myopic vision.

Below is an extract from a flyer on SAP BusinessByDemand, a SAAS offering from SAP and why I find it so disappointing. The biggest disappointment is obsession with cost reduction rather than throughput (sales minus totally variable cost) increase.

Summary	My Comments
The SAP® Business ByDesign™ solution is an on-demand solution that comes with the extensive expertise and stability of SAP. This solution helps enhance growth, productivity, and collaboration and provides lower, more predictable IT costs. SAP experts fully manage, monitor, and maintain the solution in hosted data centers worldwide, freeing you to focus on growing your business.
Business Challenges
• Streamline business processes without incurring significant IT capital costs	Instead of highlighting the reduction in costs, it would be great to highlight how ERP can help "Exploit the Constraint" to squeeze out maximum throughput for the given investment in business. The transparency is required for internal stakeholders more than the external stakeholders to prevent accumulation of inertia and unnecessary inventory in any part of the organization. Rather than managing complexity, it should highlight how the whole thing can be simplified by ensuring WIN-WIN situation for all the components of Supply-Chain. This can be done by reporting the Throughput-Dollar-Days and Inventory-Dollar-Days for different players in the Supply-Chain.
• Meet increased requirements for transparency and reporting
• Preserve and expand customer base
• Manage logistical and supply chain complexity
• Improve employee productivity and collaboration
Key Features
• Financials and compliance – Generate trusted, up-to-date data that lets you perform financial reporting, make informed management decisions, and enable regulatory compliance • IT on demand – Reduce costs and increase control with a single, flexible business management solution	The most important feature should be managing operations using Simplified Drum-Buffer-Rope (S-DBR) for Production environment and Critical Chain Project Management (CCPM) for Project environment. The focus again should be on increasing throughput, creating conflict free environment within and outside the organization rather than shaving some imaginary costs.
• Customer service and support – Use customer relationship management processes to improve service with a new understanding of costs and profitability
• Workforce management – Enhance HR operations and maximize employee potential
• Procurement – Strengthen relationships with suppliers and streamline purchasing processes
• Supply chain – Cut costs and improve effectiveness of supplier relationships and logistics
Business Benefits
• Get up and running quickly with streamlined business processes and a 360-degree view of your business	Reduction in lead-time Increasing the reliability in delivery measured as On-time-in-full delivery % Reduction in inventory Increase in sales. Reduction in material costs, Reduction in the days of outstanding receivables
• Reduce IT costs with smooth, predictable deployment and operation as well as built-in service and support
• Enhance employee productivity and collaboration using a single solution interface, personalized business portals for each employee, and built-in user help
• Make better-informed decisions faster using analytics and dashboards
• Improve flexibility and reduce risk by adapting the business to changing

Language of Metrics – Stake-holder Trust (Part 3)

Any organization that aspires to survive on a long term basis has to strive to be perceived as trustworthy by all its stakeholders – Investors, Customers, Associates and Society. It needs to strive to be actually held in very high regard by each of the stakeholders. Ignoring anyone of the stakeholder will in the long run result in others also starting to distrust the organization.

TRUST is very abstract and very difficult to put one's hands around. We can only look at signs of trust or distrust.

To me TRUST and SIMPLE are two faces of the same coin. SIMPLE inspires TRUST and what we TRUST on closer inspection turns out to be SIMPLE.

We resort to have an intricate web of metrics to keep a tab on how the organization is faring with regards to expectations of different stakeholders. We also come across frequent internal and external surveys conducted amongst a sample or the entire stakeholder population to gauge the health of relationship with the stakeholder community. The survey results are fed into involved set of formulae to calculate various indices e.g. Associate Delight Index, Customer Delight Index (both for internal and external). Apart from this, organizations nominate themselves to external awards given out by ostensibly independent and un-interested agencies. Winning an award is considered to reflect organization having reached the pinnacle of glory and have a rub-off on the image amongst the stakeholders.

My belief is that all the above is started in good faith initially. Over a period of time, managers / leaders fail at re-evaluating the efficacy of these steps and take measures to replace with more relevant and appropriate steps. Continuity provides a semblance of safety due to familiarity. After an initial period of euphoria, conducting these surveys and publishing the indices becomes a routine.

The following can be considered a basics or hygiene metrics that keep the real picture of stakeholder relationship rooted to firm ground. The metrics are by nature 'Lag' measures:

1. Investors
   
   1. Investors' basic interest is to get returns over a period of time. They allot a portion of their investible funds to an organization's shares with an expectation of returns. Simple metric is the consistency and growth of the "Return on Equity".
      
   2. Apart from this all the investor related interests are captured in the P/E multiple that the company share commands on the stock exchange in comparison with other companies in the same or related sectors.
      
2. Customers
   
   1. Growth rate of revenues in comparison with the competition and market segment per-se.
      
   2. Percentage of customers giving repeat business
      
   3. Percentage of total revenues accounted by existing customers
      
   4. Price premium enjoyed by the firm's products and services compared to competition
      
   5. Percentage of existing customers eschewing competitive bidding on a large scale when the service business contract is up for renewal.
      
3. Associates
   
   1. Attrition
      
   2. Presence of 360 degree appraisal at all levels
      
   3. Presence of credible internal fora where associate involvement is sought and valued. The essence here is credibility and is reflected by the number of suggestions given by employees implemented in the right spirit.
      
   4. Percentage of new recruitment attributed to employee referrals
      
   5. Percentage of top positions filled by internally promoted employees
      
   6. If the company visits campuses for entry level recruitment, then the priority given to it in the campus recruitment process reflected by the slot made available on first, second or later day. This is in most parts a reflection of the entry level salaries offered by the company in comparison with other organizations who are in the fray for attracting fresh talent off the campus.
      
4. Society / Ecosystem
   
   1. Extent of integration of the company's processes with the vendors' / suppliers'. This indicates the confidence of the organization in opening itself to transparent involvement of the vendors or the TRUST that the company is ready to lend to others.
      
   2. Supplier selection based on reliability, quality and responsiveness and not just on price.
      

There is a case of demonstrating seriousness in winning TRUST of all the stakeholders concerned.

There are no easy solutions and one can debate on the approach endlessly.

The idea here is to have a comprehensive set of 'Lag' measures which cater to all the stakeholders and at the same time the set is so SIMPLE and Common-Sense that it can be understood by each and everyone in the organization. The above set has 15 metrics and the number can at best be stretched to 20 but as mentioned earlier, having more and complex set does not ensure completeness but more confusion.

Language of Metrics (The bare minimum)(Part 2)

When we start a talk on metrics and measurement, the following is most quoted quote."What gets measured gets done".

Does this mean that everything that needs to be done should be measured? There is a real danger of falling into a trap of thinking 'more the merrier'. There is distinct possibility of thinking that if we have sufficient and more measures than it is safer rather than having less measures and allowing something to slip through the cracks!!! This line of thinking can take the form a guideline which states - discover new measures every-time you face a tough situation. We must keep in mind - "Not everything that counts can be counted and not everything that is counted counts"

We might create a royal mess and keep on digging ourselves in a deeper hole. The above line of thinking belies the systems thinking and 'inherent simplicity' that Goldratt often refers. Inherent Simplicity asserts that whatever complexity that we see on the surface, hides a simple representation - an elegant and simple solution at the heart of any problem.

Then, what is the bare minimum that we need to have in our performance measurement framework, to be confident that reflects our understanding of the 'system' that we are part of as well as an insurance that nothing is being left unaddressed!!

A tall order!!

Following are the category of measures given in "Reaching the Goal – By John Arthur Ricketts".

1. Financial – To keep focus on the 'purpose' of the business from the key stakeholder, investors' perspective.


2. Performance – To help take stock of the affairs on a frequent basis on 'how well' the enterprise in doing in the above from the perspective of quantum and efficiency
   
3. Resource – To help the managers in taking decisions related to short term product mix, market mix by evaluating the 'exploitation' of the 'constraint' or the bottleneck.


4. Decision support – To help the managers in decisions related to the longer term product mix, market mix by evaluating the 'elevation' of the constraint or the bottleneck and creating new 'Assets' and deploying initiatives.
   
5. Control – To help managers to keep regular business on track by protecting the 'constraint' from the regular and un-predictable disturbances.
   

This set of five categories of measure help in meeting the two criteria discussed in previous posting.

1. Financial Measures.
   
   

   Any commercial enterprise is created and exists to generate wealth for the stakeholders. The unit of measurement for wealth is the currency in which the business operates.
   

   These measures irrespective of the type of organization, manufacturing, services, software, should answer the following questions:
   

• How much money is generated by the enterprise?
  
• How much money is spent to operate it?
  
• How much money is captured by it?
  

We know the answers to above questions from our knowledge of Throughput Accounting

• Throughput (T),
  
• Operating Expense (OE),
  
• Inventory/Investment (I).
  

Throughput Accounting concepts warns us to be very clear of what are "Truly Variable Costs" and not fall prey to phantom of cost accounting measures which considers labour as variable cost and this leads to some very damaging conclusions related to efficiencies, and product / service costing.

Some hints and tips:

• Throughput is measured in the "goal units" produced by the system.
  
  
• When the goal units are money (for-profit businesses), throughput (T) in the simplest sense is merely:
  
• [ Sales revenues (S) ] – [ Cost of the raw materials (RM) ]:
  
  
• T = S - RM
  
• Note that T only exists when there is a sale of the product.
  
  
• Producing products that sit in a warehouse does not count toward throughput
  
• Throughput is sometimes referred to as "throughput contribution" and has similarities to the concept of "contribution" in other cost accounting methods, which is sales revenues less "variable" costs.


• But in throughput accounting (TA), the ONLY variable cost is the cost incurred if a product is actually made.


• Thus for TA, variable costs are primarily raw materials, but can include things like transportation costs and purchased services required to actually build products.


• In TA, variable costs are only those costs that vary proportionally with the number/amount of product produced, i.e.
  
  
• If you make twice as many widgets,
  
• You need twice as many nuts and bolts to assemble the widgets,


• So you need to spend more money to buy nuts and bolts.


• For the TA approach, costs such as labor are NOT considered as variable costs.
  
  
  
  
  • The reasoning is that you don't send people home if the widget making line is down - they are still being paid a wage for the hours they are at work,
  
  
  • So at the system level, the labor cost associated with making widgets does not vary with the number of widgets made,
  
  
  • Since, you are still paying for the people in any case
    


• Investment is all the money tied up the system.
  
  
  
  
  • This is money associated with inventory, machinery, buildings, and other assets and liabilities.
  
  
  • In earlier Theory of Constraints (TOC) documentation, the "I" was interchanged between "Inventory" and "Investment." The preferred term is now only "Investment."
  
  
  • Note that TOC recommends inventory be valued strictly on totally variable cost associated with creating the inventory, not with additional cost allocations from overhead.
  
  
  • In other words, the value of inventory is only the money
    paid to outside suppliers to purchase the materials put into the inventory.
  
  
  • It does not include the money spent by the organization to process the raw materials as they flow through the system.
    
    

• Operating expense is the money the organization spends in generating "goal units" – e.g. products.
  
  


• For physical products, OE includes maintenance, utilities, rent, taxes, payroll, etc., but does not include variable costs, e.g., raw materials.


• Generally, OE are all expenses that are incurred as a result of the passage of time regardless of how many units are produced.


• OE is the price the organization pays to maintain its current capacity to produce products, regardless of whether or not products are produced.
  
• Specifically, it includes all employee time, regardless of what they are (or are not) doing.

1. Performance Measures

These measures quantify progress towards an organization's goal. These measures can be calculated at the overall organization level as well as self contained business units, projects, process etc levels to align behavior and decision making at local level in accordance with the global good.

• Net Profit = Throughput – Operating Expense


• Return on Investment = Net Profit / Investment


• Productivity = Throughput / Operating Expense

On the face of it, the above measures look conventional but since there is a subtle difference in underlying Financial Measures, hence the resulting performance measures are different.

The basic thumb-rule while evaluating the performance of a sub-unit using these measures is to consider T, I and OE which are in direct control of the sub-unit owner / leader. The allocation of the unit / head-office cost etc should not be done. The decision to improve local performance based on these measures lead to improvement of the global performance.

1. Resource Measures
   

Although, measuring efficiency or resource utilization to ensure 100% utilization is not what is advocated in Throughput Accounting, still in service organizations, resources form an important component of the I and OE.

Resource measures being local efficiency measures should not be used for behavior influence. The resource measures at the constraint / bottleneck help in deciding the product / service mix for maximizing throughput.

• Totally Variable Cost (TVC) for each specific sale transaction – this includes subcontractor fees, commissions, travel and living expenses, and so on.


• Throughput per Constraint Unit: T/ CU – this measure is used to prioritize use of the constraint by selecting the product mix that maximizes throughput.


• Utilization: U = Time a resource spends producing / Time available to produce

1. Decision Support Measures
   
   
   

   Organization Management needs to take decision related to capital investments, addressing new markets – geographies, segments, introducing new products / services, improving processes, etc. The defining characteristics of such decisions is that it impacts the "Asset Creation" for the business and putting these 'Assets' to specific markets, offerings etc.
   These decisions also have the potential to shift the constraint or require the enterprise to forfeit some T on some existing product / services to gain more T on new product / services. In stable constraint and existing product / services the resource measure T/CU is adequate but for other cases following measures give an appropriate direction

• Change in Net Profit: ∆NP = ∆T - ∆OE


• Payback: PB = ∆NP / ∆I

Here ∆ is the symbol for Delta or the difference between two alternatives or before/after scenarios being compared. These measures can also throw light on the initiatives being taken in different times. E.g. a proposed cost cutting initiative that slashes OE and requires no ∆I will look a lot less appealing if it also jeopardizes T to the point that ∆NP is significant or erratic. Conversely, an investment proposal with only ∆NP can look quite appealing if its ∆I is trivial and resources are readily available or ∆OE is zero.

1. Control Measures
   
   
   

   These set of measures are unique contribution of Goldratt and Throughput Accounting. These measures deal with a new concept of time-money. When we think of investment evaluation we know of common terms of Net Present Value (NPV) or payback period. These terms deal with either money (NPV) or time (Payback), at a time but not both at the same time. These are obtained by multiplying the two and getting measures called 'Dollar Days'.
   

   Throughput Dollar Days (TDD): This measure is used in production as well as in supply chain to evaluate the performance of supplying units against the due date of shipment. It is calculated for lost sales/ delay of shipment beyond the committed date by multiplying the sale value of the order with the number of days delayed. This is accumulated for the units / departments which are responsible for the delay and results in negative light on the department. This influences the right kind of behavior as it increases very quickly with each passing day and is more damaging for the larger orders. It also helps in ensuring that people complete a task right first time as any return of material creates a significant addition of TDD on the department which needs to contribute rework.
   

   Inventory Dollar Days (IDD): This measure is used to in production as well in supply chain to evaluate the performance of the receiving units against the utilization of 'Inventory' retained by the supplying unit to ensure no stock out. It also ensures that the sales team sells what is available in stock and ensures that the old inventory does not pile up and clog the pipeline and lock up the precious working capital. It is calculated by multiplying the inventory value over the buffer stock agreed upon with the number of days it stays above the agreed upon level.
   
   

   Project or Process Dollar per Day (PDD): This measure is used for projects and processes. This is the rate at which a project or a process produces Net Profit. PDD = NP / Days (Duration of the project), (NP = T- OE). This promotes on time delivery of the project against the negotiated duration. When a project is late, i.e Denominator increases, the throughput expected from the project remains same whereas the Operating Expense increases i.e the Net Profit i.e. the numerator goes down. The combined effect is shrinking of PDD. In general, the higher the value of PDD, the better. PDD can be negative for unprofitable projects. PDD is calculated based on NP rather than T to encourage delivery within budget as well as on time. PDD can measure individual projects / contracts or a set of projects / contracts, for a specific duration or their entire duration, can be used to compare completed, active or planned projects / contracts.
   

   
   

   Resource Dollar per Day (RDD): This measure is used for projects and processes. This is the rate at which excess resources erode the NP by generating OE without the corresponding T and which cannot be considered as an I (Investment). Like IDD it discourages unnecessary investment in resources.

Language of Metrics (Criteria of Soundness) (Part 1)

How do we evaluate the operational measures framework used by any organization?

Does the framework act like a lighthouse giving accurate direction to the ship or does it create a fog, throwing the organization off-the-track without even it being aware?

Does the framework represent the deep understanding of 'inherent simplicity' or it mirrors the superficial complexity of the organization?

Any organization is a combination of many parts which need to gel well in order to achieve the overall GOAL of the organization consistently over a period of time.

It requires tremendous effort to ensure alignment of various parts to bring about 'synergy' and to also ensure that the parts are not working at counter purpose to each other. We depend on elaborate business performance measurement to get the alignment of the units, sub-units, individual leaders and associates, whether it is Balanced Scorecard based or indigenously developed measurement system.

Eliyahu Goldratt has famously said:

"Tell me how you measure me, and I will tell you how I will behave. If you measure me in an illogical way...do not complain about my illogical behaviour"

End of the day any measurement system is to induce 'behaviour' as organizations are 'people' based systems.

The two main criteria for evaluating any measurement system are:

1. Does it induce the parts to do what is good for the system (organization) as a whole?

This is to ensure that leaders and associates do not focus on local optima but on global optima. A good measurement system should not create any conflict in people's minds while deciding their actions as to what leads to global good. Goldratt has railed against Cost Accounting based measures like efficiency and product costing proving that these create debilitating conflicts and many times resulting in decisions which lead to ruin of organizations. In his business novels, he gives umpteen examples where in the name of increasing labor efficiencies, machine utilization, reducing head-count etc people take decisions which go against ‘common-sense’ just keep up and look good as per the prevailing measurement system.

The global good also needs to be sharply defined rather than vague statements like 'We want to be the best'. Goldratt suggests that for commercial organizations with shares listed on stock exchanges, the Goal has to be "Making money now as well as in future." All the other issues like customer satisfaction, loyal employees, high quality products/services etc can be the critical success factors or necessary conditions for this high level GOAL of the organization.

2. Does it direct the managers to the point that needs their attention (sometimes very urgent, sometimes not so urgent)?

This relates to focus. In an environment of limited time, attention and resources, wasting these precious things on unimportant issues can again result in debilitating consequences.

Losing focus is one thing a manager/leader cannot afford. A measurement system with too many measures has the capacity to create confusion and result in loss of focus.

There is a general belief that 'Any action is better than no action. Perhaps the action you take will be successful; perhaps different action or adjustments will have to follow'.

In a scenario where a manager is presented with multitude of measures, there could be a tendency to 'ACT' to improve some of the measures which are easier to improve and which do not involve tougher decisions, more analysis, resolving apparent conflicts etc. This could lead to a false sense of accomplishment but the reality might be that a decision / action which is most important at that point of time is left unattended or just ignored. Such a scenario is ripe to spring nasty surprises as the unattended 'necessary action' deteriorates the whole system apparently invisibly and suddenly the break / crack in the system appears on the surface. In some cases it gives an impression which is very close to Nero playing fiddle while the Rome was burning.

A typical example is in project management where there are situations when 90% of the project is finished in a year (as scheduled / budgeted) but the remaining 10% takes another year. This points to the failure of the measurement system which proclaims 90% of the work is done. The project manager who is measured on the quantum of work irrespective of the fact whether the activity lies on the critical path or a feeder / non-critical path is tempted to focus on the non-critical path whenever there are conflicts, resource contentions on the critical path. The measurement system does not alert such foolhardy decisions in advance which results in the nasty surprise of budget and schedule overruns when nothing but activities on critical path as pending.

In the next post, we will examine how we can go about building such framework which will meet the above two basic criteria.